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You wish you could pay less than the full tax plus penalties plus interest? So does everyone. Here’s my Consumer Alert for the day: some truth about paying off the IRS when you owe taxes.

There is a constant barrage of misinformation about the whole process of getting out from underneath a tax debt. The “adjusted reality” comes from people who would like to take some money from you. Here’s the straight scoop. Without the fairy tales.

INTEREST

First things first. Interest. When you owe the IRS money, it accrues interest. By law, the IRS cannot waive interest. This means that no matter what anyone tells you, the interest is not going to go away.

So when you see that advertisement on TV (late night cable at my house), or on the radio (though I haven’t heard them lately on KNX, so I think those guys are history), or elsewhere, just remember that whatever they’re going to do, they can’t do anything with interest.

The best they can do is reduce the tax itself, which means the principal on which the interest is calculated is lower, and therefore the interest itself is less. (Interest on $10,000 of tax liability is less than interest on $20,000 of tax liability). But as you will see below, that’s easier said than done.

PENALTIES

Next. Penalties. Some penalties can be waived, some not. Don’t assume that the penalties will be waived just because you ask. There are guidelines for the IRS to operate within, when deciding whether penalties can be waived or not.

But there’s an equally — or more than equally — important factor. That’s the IRS agent who’s assigned to your case. Like the entire population, there are reasonable IRS agents and (ahem) others. It’s the luck of the draw as to who is assigned to your case. But the bottom line is that you should not expect to get penalties released, barring some exceptionally good reasons. Death, severe illness, earthquake. Stuff like that can work. “The Dog Ate My Homework” level of excuse won’t.

TAX

OK. Here’s the big one. The actual tax liability itself. The big promise is that these tax professionals can negotiate with the IRS, and come up with a number where you pay “pennies on the dollar.” When you owe a ton of money, those words are magic. Oxygen. Hope.

Understand one thing and one thing well. The Internal Revenue Service is a bureaucracy with rigid, deeply entrenched procedures for EVERYTHING. Yes, there is some slack in the system. There are some things upon which the IRS agents can make judgment calls. But for the most part you’re on a fixed course from which you can’t deviate.

So when you go to them and want to pay less than 100% of the amount you owe, they reply “We have a procedure for that!” It’s called an Offer in Compromise.

The procedure is explained in an IRS booklet (PDF). This gives you a step-by-step action plan for doing an offer in compromise.

I’m not saying you should do it yourself. You could. But there are good reasons to use a third party as a buffer between you and the IRS. Experience is just one of them. (The IRS officer has seen hundreds of these. Your professional has, too. You’ve never seen one. The likelihood that your adviser will get it done right, efficiently, is much higher simply because of experience).

But it’s up to you. You can do it yourself If (1) you can follow directions, (2) you can be honest–anything you tell the IRS should be capable of being backed up with documents, and (3) you can be reliable–if you tell the IRS they’ll get something on Tuesday, they get it on Tuesday.

But here’s the bottom line. The IRS isn’t going to take less than 100 cents on the dollar if they think that through normal collection procedures (and patience) they can collect in full. They have a formula for what they think is an acceptable offer. See pages 8 and 9 of the IRS booklet. This gives you a clue about what they want. They look at your current net worth (your assets right now) and your future income stream, and come up with a number that they’ll accept.

In many, many, many cases I see, the numbers just don’t work. The person has a job, has a house with some equity, has some assets. The acceptable number for a settlement frequently looks like 100%, according to the IRS. Don’t believe the “pennies on the dollar” promises until you’ve done that worksheet and have an inkling of what the IRS thinks is a good number.

WHY YOU WOULD DO AN OFFER IN COMPROMISE

You would do an offer in compromise if you can persuade the IRS that there is a real doubt as to whether you’re liable for the tax.

You would do an offer in compromise if you can persuade the IRS that they probably won’t be able to collect from you. E.g., your current economic situation stinks, and looks like it will stink for a long time to come. An example: in the good old days you invested in a tax shelter. But you’re not working now and you have no more assets to speak of. The tax shelter went bust and you owe a bunch of tax. The IRS sees you as someone with no assets they can seize and sell, and only Social Security as income (which they can’t touch). You can do well in a situation like this.

ALTERNATIVES TO AN OFFER IN COMPROMISE

Your alternatives (if you owe money to the IRS) are:

1. Offer in compromise;
2. An installment plan (work out an agreement for paying off the tax debt over time);
3. Bankruptcy (yes, bankruptcy can wipe out tax debt); or
4. Wait (the IRS has 10 years–as a general rule–to collect a tax debt).

SUMMARY AND THE USUAL DISCLAIMER

The reality of clearing up tax liabilities to the IRS is that it isn’t easy, and there is no magic. You’re only going to settle for “pennies on the dollar” if you don’t have assets and you don’t have income. Don’t expect miracles.

This — like everything on this website — is not legal advice to you individually. Don’t go running off and do something foolish, then blame me. I’m not your lawyer just because you read this post on my website.

You have alternatives to consider. Get to know the alternatives and why one choice is better than another–for you. There may be some extraordinary circumstances that you have which will make a difference and save you some money. Go spend some money on an experienced tax lawyer or CPA. And when you do, ignore the siren song of “pennies on the dollar” until it’s proven that you qualify.